Wash Sale Rule Buying Stock Within 30 Days Loses Deduction

Updated on October 6, 2010

IRS Wash Sale Rule

Even great investors have losses. Warren Buffet had big losses in 2008 as did plenty of other investors. Fortunately, the IRS allows you to offset your capital gains by deducting capital losses from investing gains. In other words, your investing losses reduce your capital gains taxes.

The best part is that short-term capital losses offset short-term capital gains. This is important because there is capital gains tax relief for long-term investments. Investments held for over one year, are subject to the capital gains tax rate of just 15% for most investors. However, the short-term capital gains tax rate is equal to the ordinary income tax rate for the investor. That means that the short-term capital gains taxes can be as high as 35%!

Before you race out and sell a losing position to generate a capital investing loss, make sure you understand the IRS wash sale rules. A wash sale occurs when an investor sells a stock or other security and then buys the same stock within 30 days. Don't bother trying to get around the wash sale rule by buying the stock option or call either. The rule prohibit those transactions as well.

Avoid Wash Sale Strategy

Avoiding a wash sale isn't as hard as it sounds. While investment do perform drastically different over time, many investments move in similar fashion over shorter periods of time. For example, over a 30 day time period, many stocks within the same sector will move at close to the same percentage. So, if Sears moves up 3% in 30 days, another stock, like Target stock, is likely to move up by about the same amount, assuming there is no major news development during that month.

For investors holding mutual funds, index funds, or ETFs, avoiding a wash sale is even easier.

While closely related stocks are likely to move up or down in similar fashion over a one-month time frame, indexes or similar structure mutual funds, such as large-cap funds are even more likely to track each other, even more closely.

For example, over a 30 day period of time, the S&P500 Index will likely move in close proportion to the S&P1000 Index. An investor looking to generate capital losses in order to have investment losses to offset gains with, could sell an S&P500 Index Fund and immediately purchase a S&P1000 ETF. If the stock market goes up in a rapid bull market move, the S&P 1000 Index fund will rise just like the S&P 500 Index fund would. The overall amount will be slightly different, but on a percentage basis, they are likely to very close.

The difference between the investment returns is a small price to pay for generating a short-term capital loss that could save on capital-gains taxes to the tune of 30% or 35%!

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